Rural commercial banks are experiencing credit downgrades as new loan classification rules force them to recognise souring loans as NPLs and set aside more capital against bad debt.
Chinese rural commercial banks have seen increasing deteriorating capital and asset quality as a result of new rules requiring them to recognise bad loans more quickly, reports China Money Network.
As of Q1 this year, the NPL (non-performing loans) ratio at rural commercial banks was 3.26%, significantly higher than other types of banks amid tighter rules aimed at exposing hidden credit risks in the banking system. According to the report, five out of six banks downgraded this year were rural commercial banks.
Shandong Zouping Rural Commercial Bank was one of these banks, recently downgraded and given a negative outlook by credit ratings agency Golden Credit Management, based on a 10.49% NPL ratio at the end of March, up from 9.28% just three months earlier and 2.43% in 2016. The rising NPL ratio is reportedly the result of loans souring after manufacturers were required by Beijing to reduce excess capacity and strengthen environmental protection.
With more capital needing to be set aside for its bad loans, the Shandong Zouping’s 2017 capital adequacy ratio fell to 7.12% from 11.73% a year earlier, while its tier 1 capital adequacy ratio fell to 6.22% from 10.58% over the same period. The bank’s provision coverage ratio fell to 59.28%, significantly lower than the required range of between 120% and 150%.
Meanwhile, Guiyang Rural Commercial Bank was also downgraded after seeing its NPL ratio rise to 19.54% at the end of 2017. This was directly attributed to China’s tightened loan classification rules.
The new policies on loan classification require banks to recognise loans as NPLs if principal or interest is overdue for more than 90 days. In the past, they had greater flexibility to avoid classifying loans as NPLs, instead treating them as ‘special mention loans’ and allowing them to set aside less capital for bad debt. Estimates suggest that special mention loans account for some 20% of total debt at Chinese banks.
As banks reclassify overdue loans as NPLs, they will end up needing more capital to meet regulatory requirements, and according to the report, rural commercial banks are being hit the hardest as they mainly serve SMEs which are more likely to default due to their vulnerability to economic shifts.
On the other hand, China’s four largest banks and most joint stock commercial banks have acted with relative prudence in their loan classification, said an FT report earlier this month, which mitigates the risk to the financial system as a whole.
Still, the report suggested that bad debts across the country’s banking system will rise by 14% this year, with up to 51 banks falling below the new bad loan coverage requirements.